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When the global recession hit, shipping companies saw rates plunge by more than 90%. However, as the world has begun to emerge from the downturn, the Baltic Dry Index shows that rates have begun to recover from their lows, though they still remain far below peak levels.

I spoke with the chief operating officer of DryShips, Pankaj Khanna, to gain some insight on the company's prospects for 2010. Khanna says business is good and that DryShips is poised for a better 2010 than 2009. He also says DryShips plans to take its DrillShips business public this year.

What follows is an edited transcript of our conversation.

Jennifer Schonberger: What are you seeing now? How's business?

Pankaj Khanna: Business is pretty good. The fleet increased last year by, say, 4% to 6%. Despite that, we had a pretty good market last year. In fact, the last three quarters of the year were very strong. The first quarter there was pretty much nothing going on because there was a lack of credit. The start of the year this year, things are again still very strong. The Capes [capesize vessels] are running about $40,000 per day; the Panamax is averaging about 30. So it’s not like the peak markets of 2007, but at the same time, at $40,000 per day per Cape, it’s a pretty healthy level.

Schonberger: I noticed you haven’t reported your fourth-quarter results. When are you scheduled to report?

Khanna: We haven’t announced that yet, so we can't make selective disclosure. Typically, the fourth-quarter results do not come out until some time in February. It's still early. I think most shipping companies start their reporting cycle somewhere around the 10th to 15th of February. We'll be on time as per usual. It won't be late.

Schonberger: How did your fourth quarter shape up?

Khanna: It was as per our expectations. There was nothing unexpected.

Schonberger: Will 2010 be better than 2009?

Khanna: Absolutely. [In] 2009, we faced a recession. We had the worst credit crisis the industry has faced in probably 30 years, and 2010 is shaping up to be much better than 2009.

Schonberger: How has the vessel oversupply crisis affected DryShips specifically? Have you had to delay or cancel any vessels under the current circumstances?

Khanna: Yes. We canceled several vessels at the beginning of 2009, and some through the year as well. I think we canceled 18 or 19 vessels in total. But we don't have any new buildings on order now.

Schonberger: What is your outlook for your DrillShips business in 2010?

Khanna: ... We are focused on the ultra-deepwater. We have two drilling rigs under contract. One is in contract to Petrobras (NYSE: PBR) ; the other is in contract to Tullow Oil.

Then there are four more drillships that are under construction at Samsung. If you look at the ultra-deepwater sector, most of these projects arrive at anywhere between $50 to $55 per barrel for crude oil. With oil prices in the $70 to $80 a barrel range, most of the projects are viable.

We've seen a big increase in the tendering activity in the last two months. So we expect that in 2010, we'll probably be able to fix those four drill ships that are under construction at good rates. Rates have held up through this last year ... at $500,000 per day. At $500,000 per day, we pay off our investment in five to seven years. There are very few businesses where you can pay off your business in five to seven years and still have an asset that has another 25 years of life left.

Schonberger: I understand you'd like to eventually separate the DrillShips unit through spinning it off [in] an IPO. What's your timeline on that?

Khanna: Our time line on that is sometime this year.

Schonberger: Obviously, you're beginning to try to diversify your revenue stream from solely the dry bulk space -- with two-thirds of your business now [made up of] DrillShips. Are there other new areas you're looking to pursue?

Khanna: This wasn't the strategy of just pure diversification. The whole thing started because DrillShips was a good business. In shipping, typically you pay off the ships in 15 to 20 years. You have a business [in drill ships] where you can pay off the asset in five to seven years and still have a lot of life left. ...

Now, as you understand, there is some distress in the shipping business right now. Tankers had some bad markets last year. The rates are good now, but maybe they'll come down again to the levels we saw through the summer and into October, November, December of last year. So we may look at tankers. But dry bulk is the core business for DryShips. We've said this publicly on the conference calls in the past.

Schonberger: DryShips was highly leveraged pre-global recession, and then you had to recapitalize through a series of share issuances to shore up your debt position. Where are you in that process? Do you expect to issue more shares?

Khanna: The last time we issued any shares was May of last year ... We have $1 billion of cash on the balance sheet; why would we issue equity at this time?

Schonberger: What about plans to take on more debt?

Khanna: We only take on debt when required, and the only place where we have capacity to take on debt is in DrillShips. We have the four DrillShips under construction. Two are mostly financed; two are not. So [for] the two that are not financed, we could take on another $900 million to $1 billion in debt on those vessels.

Schonberger: Any plans to reinstate the dividend any time soon?

Khanna: We're always studying that. But at this time, with capex of over $2 billion outstanding, I don't think it would be wise to reinstitute the dividend. [After] the IPO of DrillShips and once the drill ships are all functioning, they'll be generating a lot of cash, so we may consider a dividend then -- post-IPO. But at this point, I don't think it makes any sense to reinstitute the dividend.

Schonberger: Since you are a Greece-based company, what are your thoughts on Greece's fiscal situation? And does the country's situation affect your company in any way?

Khanna: Greece's economic situation hasn't affected us as a company. We have some minor lending from Greek banks, but most of the Greek banks are still well-capitalized, and we don’t see any problems with that. Anyway, we're their creditors. We don't anticipate our business being affected by this at all.

Schonberger: What's your case for your stock?

Khanna: We think the company is very cheap, with the stock trading at $6 and change. We think our NAV on dry bulk and the cash alone is about $6. So when you buy DryShips at $6, you’re basically getting the drill ships for free. I think we're working to release that valuation by doing the IPO, as I told you.

If you missed the first part of this interview, which included DryShips COO Pankaj Khanna’s thoughts on the overall shipping industry and his expectations for 2010, click here.

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Dryships has only two employees, its CEO and a CFO, and so will conduct virtually all of its operations through Cardiff, which Economou created back in 1991. It’s right there, under risk factors, on page 12 of the prospectus. And all that a prospective shareholder had to do was flip to the top of the next page to learn, “you will have no recourse against Cardiff.” A little farther down that same page, furthermore, some fairly standard boilerplate verbiage about Economou’s stakes in both Cardiff and Dryships creating potential conflicts of interest is capped with an unusually blunt warning that blood is thicker than water: “Cardiff may give preferential treatment to vessels that are beneficially owned by related parties because Mr. Economou and members of his family may receive greater economic benefits.”

Dryships has only two employees, its CEO and a CFO, and so will conduct virtually all of its operations through Cardiff, which Economou created back in 1991. It’s right there, under risk factors, on page 12 of the prospectus. And all that a prospective shareholder had to do was flip to the top of the next page to learn, “you will have no recourse against Cardiff.” A little farther down that same page, furthermore, some fairly standard boilerplate verbiage about Economou’s stakes in both Cardiff and Dryships creating potential conflicts of interest is capped with an unusually blunt warning that blood is thicker than water: “Cardiff may give preferential treatment to vessels that are beneficially owned by related parties because Mr. Economou and members of his family may receive greater economic benefits.”

Wtf? Who cares about baltic rates if the guy at the head is stealing from the shareholders?

According to an article I'd read in Seeking Alpha from Fe. 2009, someone from Dryships Investor Relations mentioned that once the Drillships were spun off as an IPO, current Dryships investors would receive 1 share of the spin off per every DRYS share owned.

So, if you owned 1,000 shares of DRYS, you'd also own 1,000 shares of the drill ship stock, to cash in and use as a dividend or hold onto...according to the Investor Relations person.

The person claimed that each IPO share would be approximately valued at $30/share.

Ms. Schonberger, do you have any info of this nature to relay to us now regarding this possible decision by DRYS? Please get back to us on this.

Here's the specific excerpt: (keep in mind that this is from a year ago)

"DRYS has announced that it is planning to spin off its Ocean Rig holdings as a new company by issuing shares as a dividend to its shareholders. The regular dividend has been cancelled. However, I have not heard that this dividend has been cancelled. The proposed spin off was supposed to occur in Q1 of 2009. However, I have confirmed with DRYS’ Investor Relations that the spin off has now been delayed until 2H 2009. Its format is best described by the DRYS announcement,

After we file all appropriate documents with the SEC, and once approved, we will spin-off the entity to our shareholders as a dividend. We hope to do so in the fourth quarter of 2008 or in the first quarter of 2009. This is not an IPO, as we will not raise any new equity. Simply, each shareholder in DryShips, as of the record date, will end up owning a share in DryShips and a share in the new spun-off entity, which they can then keep or sell on a U.S stock exchange, and the market will then determine the ultimate value of those shares.

At the time of the spin off announcement, DRYS made the following estimate about the likely value of the new entity’s stock.

Using several methodologies, it was estimated that the total equity value of Primelead would be between $2.55 billion and $2.80 billion, which if correct, and taking into account the 100% owned by DryShips and divided by the 63 million shares should result in a common stock price of $30 to $31 for the spun-off entity. As we showed in our recent presentation, if you assume a daily rate in excess of $675,000 per drillship, you get an EBITDA level which after applying a multiple of 5, which is the current market, you get an Enterprise Value of $900 million per drillship, or $5.4 billion for all six units. Taking out the net debt of this entity you get an equity value of about 2.7 billion. 75% of this value ($30-$31 per share) goes to the 63 million shares owned by DryShips shareholders post closing and post spin off.

DRYS itself will retain a 25% interest in Ocean Rig (according to Investor Relations at DRYS). Note that RIG trades at a 1.15 book multiple. DO trades at a price to book ratio of 2.67. NE trades at a P/B of 1.39. The Ocean Rig entity’s Price/Book ratio is likely to be higher than the average of the lower two values above.

This is a perhaps overly optimistic view of the Ocean Rig entity’s worth in the current market situation. Still, even if you cut that estimate to $10/share, DRYS would still be a great bargain. You would get the DRYS dry bulk business, which seems to be nearly the entire valuation basis for the stock at the moment ($6). Plus, you would get the Ocean Rig business entity ($10+). This is another case where the break up value of the stock is worth more than the company as one entity. The total would give you in excess of $16. Since the stock is now trading at $6, you will have made money. If oil recovers in the second half of 2009, this will make the Ocean Rig spin off entity far more valuable. If dry bulk shipping continues to improve going into the summer, the price of the DRYS dry bulk business will go up dramatically."

Ok, so it's not an IPO, but a form of dividend.

Again, is there any specific, updated information regarding this plan? Anyone want to contribute what they know? Thanks!

There is perhaps no other publicly traded company, whose fundamentals have evolved more in the last year.

That was a flawed article a year ago, and that was before all the changes.

There are now 257 million common shares outstanding, and another 60 million preferred. There is a huge difference between offering Primelead as a one for one share dividend to shareholders of DRYS, and now calling it an IPO. You have absolutely no idea how many shares outstanding there will be with Primelead, so you can't do an analysis of it's value, or PPS.

Anyone who feels comfortable that the dilution is over, or the funneling of money to Cardiff is over, has simply not been paying attention.

I always hear about the infamous BOTTOM in regards to stock. Is THIS THE BOTTOM for the DRY-BULK SHIPPERS ? I feel this industry is the backbone of all nations in reguard to the economy.I just went long on drys.well at least until it pops back to 6-7 range what do you guys think am i crazy,right,or another drys sucker!

In October 2008, George Economou flat out stated, "We are not in danger of violating our loan covenants, and have no reason to issue more shares."

Since that bold statement, by George, DRYS has fallen into breach of loan covenants, and diluted by 400%.

Sure, this could be the bottom for dry bulkers, but many of these stocks will be dead money. They are not in a position to increase earnings through accretive acquisitions, and the amount of new ships hitting the water should keep rates depressed. Their book values are vastly overstated, and a normal PE for a cyclical sector like this is between 6 and 9.

The locked in charters that PRGN has, and is lauded here, is a guarantee of less revenue. Look it up on their press releases, and SEC filings, and see that the new charters are less than the old.